In crypto lending and derivatives, liquidation is the process used to reduce or close a position when it no longer meets its collateral requirements. A lending protocol may sell or transfer pledged assets to repay debt, while a derivatives venue may close a leveraged position. The trigger and execution rules depend on the particular system.12

Lending positionsReport an errorSuggest an improvement

Aave expresses a borrower's collateral buffer through a health factor: collateral value, adjusted by liquidation thresholds, divided by debt value. A value below one makes a position eligible for liquidation. This can follow a fall in collateral prices, an increase in debt value, or other changes to the position.1

An Aave liquidator repays debt and receives collateral plus a liquidation bonus. The process is permissionless and competitive. The permitted repayment fraction depends on the position and protocol rules; it is not always a complete sale of all the borrower's assets. Aave's documentation describes both partial and full-liquidation cases.1

The threshold is not identical to insolvency. A position can cross its liquidation threshold while collateral is still worth more than its debt, because the threshold incorporates a buffer. Liquidation aims to act before further price changes or execution costs consume that buffer.1

AuctionsReport an errorSuggest an improvement

Sky's documented collateral-liquidation system transfers an unsafe vault's collateral and debt into the liquidation process, then auctions collateral for DAI. Its Liquidation 2.0 design uses descending-price auctions with immediate settlement, rather than requiring bidders to leave funds locked until an auction ends.3

Auction design creates additional dependencies. The initial price, price-decay function, and limits on concurrent debt liquidation affect how quickly assets can sell. Sky's documentation lists risks from prices falling too rapidly or too slowly, oracle inputs, and governance changes that affect auctions already underway.3

Derivatives positionsReport an errorSuggest an improvement

Hyperliquid first attempts to close an under-margined account's positions through market orders. Orders may fill partially, and a backstop liquidator can take over if equity deteriorates further. Isolated and cross-margin positions expose different pools of collateral to that process.2

Liquidation does not itself guarantee that all debt is recovered. In Hyperliquid's documented auto-deleveraging process, a negative account or isolated-position value can lead to positions on the profitable opposing side being closed. This allocates the remaining shortfall through specified trading rules.4

Execution riskReport an errorSuggest an improvement

Eligibility, price measurement, and successful execution are separate steps. Aave liquidators compete to submit transactions after oracle or position changes; Sky auctions require buyers; an order-book liquidation requires available counterparties. A protocol's mathematical collateral test cannot alone ensure that the required trade will clear at the price used in that test.132

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ReferencesReport an errorSuggest an improvement

  1. ^ a b c d e Aave. Health Factor & Liquidations. https://aave.com/help/borrowing/liquidations 

  2. ^ a b c Hyperliquid documentation. Liquidations. https://hyperliquid.gitbook.io/hyperliquid-docs/trading/liquidations 

  3. ^ a b c Sky Protocol documentation. Collateral Liquidation. https://developers.skyeco.com/protocol/vaults/collateral-liquidation/ 

  4. ^ Hyperliquid documentation. Auto-deleveraging. https://hyperliquid.gitbook.io/hyperliquid-docs/trading/auto-deleveraging